Earnings Labs

Karat Packaging Inc. (KRT)

Q3 2025 Earnings Call· Fri, Nov 7, 2025

$28.47

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Transcript

Operator

Operator

Good day, and welcome to the Karat Packaging Third Quarter 2025 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. Roger Pondel. Please go ahead, sir.

Roger Pondel

Analyst

Thank you, operator. Good afternoon, everyone, and welcome to Karat Packaging's 2025 Third Quarter Conference Call. I'm Roger Pondel with PondelWilkinson, Karat Packaging's Investor Relations firm. It will be my pleasure momentarily to introduce the company's Chief Executive Officer, Alan Yu, and its Chief Financial Officer, Jian Guo. Before I turn the call over to Alan, I want to remind our listeners that today's call may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to numerous conditions, many of which are beyond the company's control, including those set forth in the Risk Factors section of the company's most recent Form 10-K as filed with the Securities and Exchange Commission, copies of which are available on the SEC's website at www.sec.gov, along with other company filings made with the SEC from time to time. Actual results could differ materially from these forward-looking statements, and Karat Packaging undertakes no obligation to update any forward-looking statements, except as required by law. Please also note that during this call, we will be discussing adjusted EBITDA, adjusted EBITDA margin, adjusted diluted earnings per share and free cash flow, which are non-GAAP financial measures as defined by SEC Regulation G. A reconciliation of the most directly comparable GAAP measures to the non-GAAP financial measures is included in today's press release, which is now posted on the company's website. And with that, I will turn the call over to CEO, Alan Yu. Alan?

Alan Yu

Analyst · William Blair

Thank you, Roger. Good afternoon, everyone. Despite ongoing trade volatility, Karat achieved another quarter of record net sales, up over 10% year-over-year, fueled by solid volume expansion, a favorable product mix and effective pricing initiatives. We've experienced double-digit growth across all major markets, especially in Texas and California. Even with significant higher import costs due to increased duties and tariffs, we successfully sustained a gross margin of 34.5% for the third quarter. We remain committed to our sourcing diversification strategy, and our nimble and flexible operating model continues to enable us to effectively manage ongoing supply chain challenges. During the third quarter, we increased domestic sourcing to approximately 20% from about 15% in the second quarter, and we reduced imports from Taiwan to approximately 42% from 58%. We continue to closely monitor tariff developments and are ready to quickly adjust our sourcing strategy accordingly as we have done in the past to maintain Karat's competitive advantage. Additionally, foreign currency exchange rate between the U.S. dollar and the new Taiwan dollar have shown increased stability since August, which is expected to help improve our operating performance for the current quarter. Earlier this year, we secured a major add-on of business to supply paper bag, a new product category for Karat to one of our largest national chain accounts. Initial shipments to select distribution centers started in the third quarter, and we expect the volume to accelerate in the fourth quarter. With fulfillment expected during Q1 of 2026, this new category of business with this chain account is for a 2-year term and expected to contribute approximately $20 million in additional annual revenue. Over the next 2 to 3 years, we aim to scale our paper bag business to more than $100 million in additional annual revenue. The anticipated growth from this…

Jian Guo

Analyst · Bank of America

Thank you, Alan. I'll begin with a summary of our Q3 performance, followed by an update on our guidance. Net sales for the 2025 third quarter were $124.5 million, up 10.4% from $112.8 million in the prior year quarter. The increase was primarily driven by an increase of $9.4 million in volume and a $3.5 million favorable impact from product mix, partially offset by a $0.7 million unfavorable year-over-year pricing comparison. Sales to chain accounts and distributors were up by 13.7%. Online sales increased 3.1% over the prior year quarter and sales to the retail channel were down 12.5% over the prior year quarter, reflecting the softness of the overall retail sector. Cost of goods sold for the 2025 third quarter increased 17.8% to $81.6 million from $69.3 million in the prior year quarter. Product costs increased $5.0 million due to sales growth, partially offset by more favorable vendor pricing and product mix. Additionally, import costs increased $8.2 million due to higher import duty and tariffs, coupled with a 21.0% increase in import volume as we purchased more inventory ahead of expected business expansion, partially offset by a 13.4% decrease in average freight container rates. Gross profit for the 2025 third quarter was $42.9 million compared with $43.5 million in the prior year quarter. Gross margin for the 2025 third quarter was 34.5% compared with 38.6% in the prior year quarter. Gross margin was negatively impacted by higher import costs, which as a percentage of net sales increased to 14.4% compared with 8.6% in the prior year quarter. The decrease in margin was partially offset by a decrease in product costs as a percentage of net sales due to more favorable vendor pricing and product mix as well as a reduction in inventory write-offs and adjustments as a percentage of…

Operator

Operator

[Operator Instructions] And the first question will come from Michael Francis with William Blair.

Michael Francis

Analyst · William Blair

Alan and Jian, it's Mike on for Ryan. Nice quarter. I wanted to start on paper bags. Did I hear you right that you aim to scale that to $100 million over the next 2 years?

Alan Yu

Analyst · William Blair

Yes, that is correct.

Michael Francis

Analyst · William Blair

And what gives you confidence in that number?

Alan Yu

Analyst · William Blair

It's because there's a lot of chains are moving away from plastic bag into paper bag. And this is a segment that we're seeing that it's -- as one of the large chains in the U.S. move towards this area, more and more similar chain will follow through that. And there -- basically, that -- we feel that there is an organic growth in that segment. And also at the same time, it is not just the paper bag was handled, there's different type of bag. There's SOS bag, which every fast food restaurant will need. And I mean with the growth of the fast food chain that is growing, the number of stores that is growing, we feel that we're competitive -- we can be competitive enough to gain market share in that segment as more and more people looking toward that area. And also, there's other bakery bag as well. There's just too many items in that segment, that make us feel that we can grow immediately. I mean, as we mentioned in our announcement that one chain, the annual sales of that number will be $20 million to $25 million per year just for one chain. And we do have 2 or 3 other chains already working in testing our paper bag and SOS bag. That's why it's -- we feel confident that this will grow quickly into an annual sales of additional $100 million a year.

Michael Francis

Analyst · William Blair

That's all good to hear. And then I wanted to ask on gross margins, went lower, I think, as we were expecting and 4Q is a little lower than we were expecting. Would like to know longer term, do you think that there's an opportunity for you to get back into that high 30% range on the gross margin number? Or is that going to be difficult while tariffs are in the market?

Alan Yu

Analyst · William Blair

Well, we're trying to be conservative right now at this point because there's still uncertainty. But the good thing is we feel there's a tailwind. One of the things that -- one of the issues that reduces our gross margin drastically in the second quarter was the sudden drop in the Taiwanese -- sudden increase in the Taiwanese dollar versus the U.S. dollar that it was a drop of 11% in just 3 days alone. And that 11% has come back to just about an increase of 4.5%, 5%. So basically, it's more of a stabilization in the U.S. dollars against Asian currencies. And this is actually enabling us to go back to our vendors to negotiate a better pricing this past 2 months basically. So we're seeing that there's more tailwind in terms of the gross margin. But we do want to be conservative in terms of how we look at in terms of the numbers in September and giving us the number that we see in October, we already see some improvement in October versus September. September was better than August. So we want to see more of the positive trend before we can issue a -- increase our gross margin numbers basically.

Michael Francis

Analyst · William Blair

Okay. And lastly for me, it's good to see the share buybacks. Would love to get an update on your capital allocation priorities between debt paydown, buybacks and the dividend and any potential M&A.

Alan Yu

Analyst · William Blair

Well, we -- our strategy is that if we have more than $20 million in short-term deposit that we can allocate it to the dividend, special dividend, regular dividend or use it for other investment. At this point, even with the increase in tariff, increase in -- inventory-wise in the second quarter, our deposit amount is still the same, remains the same. So we're still strong in cash. And lately, we're seeing that we're bringing -- we have been bringing down our inventory to reduce our cost in terms of the tariff as well as implication costs. So we're seeing cash flowing back into our accounts. And that's why we feel like it's good for us to do some type of a share repurchase. While our stock is kind of low right now, I think it's a value to repurchase share back. At the same time, we are still looking to merger and acquisition. We do have a few in the pipeline, investment, partnership, joint venture and also acquisition. We don't feel that this will deter us in terms of moving towards this direction.

Operator

Operator

The next question will come from George Staphos with Bank of America.

George Staphos

Analyst · Bank of America

Can you hear me okay, Alan?

Alan Yu

Analyst · Bank of America

Yes, I can, George.

George Staphos

Analyst · Bank of America

So listen, maybe just piggybacking on the question on capital allocation. I want to take it from a different approach. I mean your dividend basically represents the majority of your earnings per share. Why would you consider or contemplate doing more buyback in light of that? Would you consider borrowing to buy back more stock? It would seem like deleveraging and taking care of your incoming debt paydown needs would be probably more prudent. But how do you think about that?

Alan Yu

Analyst · Bank of America

Well, here's the thing. The debt -- we don't have any debt on our book right now at this point. The debt that you're seeing VIE, that's on the real estate [ side -- part ] of the ventures.

George Staphos

Analyst · Bank of America

That $20 million, that current liability, you said you're going to pay that down in the upcoming year?

Alan Yu

Analyst · Bank of America

We can pay it down. We can pay either with our current CD that we have in our short-term deposit, to utilize some of the cash on that. And at the same time, we can have third party -- we can also continue to borrow with different banks. It depends on how -- what the cash flow situation is, if there's a need to do that because right now, like I said, we don't have any debt in our Lollicup or Karat Packaging book right now. So we're -- this is one of the things that we still have time to think what we want to do, allocate our capital. If there's other things that we can do better, then we will do that. But at this currently, the rate of CD income is dropping as the interest rate reduces. So we have to figure out which is better. If we were to pay down the debt, we actually will be making -- generating additional income. It will be an interdepartment -- intercompany loan to the VIE company in paying down that debt. So it won't be like really just paying, it will be paying down the debt for the VIE company, but at the same time, for Lollicup, it will be income -- additional income. Instead of [indiscernible] us for deposits from -- yes, deposits from the banks, there will be actually more income from the VIE company.

Jian Guo

Analyst · Bank of America

And George, this is Jian. I just wanted to add on to what Alan was talking about to answer your question. The main purpose really is to have one additional tool in our toolbox to further enhance our shareholder return while we continue to focus on growing the company either organically or inorganically. As we previously announced, as you probably saw yesterday in the announcement, the total amount of the Board approved of the share repurchase program is $15 million. So it is a fairly small program at management's total discretionary. So this will be something that management will continue to evaluate in terms of a lot of the different factors, right, the pricing, the performance, the liquidity, the strength of the balance sheet, quite a few factors, just another tool in our toolbox to further enhance our shareholder return. You're right. I mean, obviously, our dividend yield is already pretty rich. So that definitely is something that we consider as we move forward with the potential execution under this program as well.

George Staphos

Analyst · Bank of America

Okay. I appreciate the thoughts on that, and thanks for the reminder on the VIE. One question, back to the question, I think Mike teed up on the bag business. So let's assume you have perfect accuracy on the revenue side on bags, and that's $100 million in whatever time period you said. What kind of margin do you think you're going to get on that business? And you're already starting to see some of that show up in the fourth quarter, you said, correct? So 2 questions there.

Alan Yu

Analyst · Bank of America

It will be a mix -- more of a mix margin. The higher volume will be in the -- could be in the high teens on margin side, and the SOS bag could be in the high 30s. So it depends on the product line. There's also bakery bag that could be in the high 50s. So -- and also at the same time, we are selling online on these new bags that we're bringing in. The online will be even in a higher margin range. So it will be more of a balancing mixture of each, just like as we are doing right now. So -- and also, we are actually working heavily toward in terms of getting our bags to manufacture more efficiently to increase margin from there, better sourcing of raw material from our vendors and also moving -- shifting the manufacturing site locations, potentially moving some into domestic U.S. production, that might save some costs, even enhancing more margin. So this is -- these are the things that we can do once -- as the volume increase in the next 12 months.

George Staphos

Analyst · Bank of America

All right. So 2 quickies for me, and I'll turn it over to Alan. So with that being the case, and we're already in November, so almost halfway through the quarter, the range on revenue growth, the range on margin is fairly wide. And I realize you're trying to be prudent. I realize there are a lot of vagaries in the market, especially with tariffs and sourcing. But I find the range is maybe a little bit wider than I would expect at this juncture in the year. What's giving you pause in terms of maybe perhaps having a little bit narrower both growth rate range and margin range for the quarter? And then did I hear you say -- and my last question, I'll turn it over. Did you say there was an inventory write-off? I apologize, I'm on the road right now, so I don't have your materials in front of me.

Alan Yu

Analyst · Bank of America

I wasn't -- I'm not sure what the inventory write-off was, but I know that we're reducing inventory at this currently for the year-end. Actually, our sales have been very robust. As you said that we are in the middle of the fourth quarter already. So we're seeing our sales almost in the mid-teen range, but we just want to be conservative. And basically, at the mid-teen range, this is a sales increase organically that we haven't seen for actually for the past 3 years. That's where -- we're seeing that 12% to 14%, but we are seeing numbers very close to the mid-teens. But we just want to be prudent in terms of 12% to 14%, that's where we're trying to -- this is where we're being conservative, but we're seeing in the mid-teens right now in the growth of numbers -- actually, the sales numbers. And basically, in our industry, this is kind of very good numbers in terms of -- well above our industry right now.

Operator

Operator

And this will conclude our question-and-answer session. I would like to turn the conference back over to Mr. Alan Yu, CEO, for any closing remarks. Please go ahead.

Alan Yu

Analyst · William Blair

Thank you. Thank you, everyone, for joining our third quarter Karat Packaging earnings conference call. I'd like to say thank you again, and have a nice day. Goodbye.

Operator

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.